Economic arguments for a carbon border tax in Europe

Economic arguments for a carbon border tax in Europe

October has already brought a major change to the global trading system: for the first time, a major trading power established a carbon import tax. Since the use of the word “tax” (or “tariff”) is not good, the European Union has chosen the so-called Carbon Border Adjustment Mechanism (CBM). But tax is what the word means, and its economic rationale is simple.

The EU already imposes an internal carbon tax. Under the Emissions Trading Scheme (ETS), power plants and large industrial facilities pay for every tonne of carbon dioxide they emit. Considering that emission permits or “allocations” cost around €90 ($95) per ton, the ETS should create a strong incentive for companies to emit less within EU borders. But the ETS does not prevent Europeans from buying the carbon-intensive products they need in other countries, especially in countries that lack national carbon taxes. These changes, known as “carbon leaks”, mean that the ETS alone is ill-equipped to achieve a significant reduction in global CO2 emissions. The MAFC should address this by requiring importers to pay (at ETS allowance rates, adjusted to reflect carbon taxes paid by the country of origin) for the emissions contained in the products that matter. .

In addition to neutralizing carbon leaks, the MAFC should protect the EU’s industrial sector. Until now, the EU’s industrial sector has received most of its emission allowances for free; This explains why the ETS has not yet made a big dent in European industrial emissions. To strengthen the effect of the scheme, the EU plans to gradually eliminate the rights of free release, a process that will start in 2026 and will take place over several years. The entry into force of the MAFC is scheduled for the same period.

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Currently, the MAFC is in its initial transition phase, where EU importers do not yet pay a carbon tax, but adjust their policies and report the emissions contained in the production of the goods they import. introduced. Besides giving importers a chance to prepare, this round gives Europe’s leaders space to soften the political opposition coming from their main trading partners.

Of course, those partners may also use this opportunity to challenge MAFC at the World Trade Organization. But if the EU ends the free emission allowances, it seems that the tax will be WTO compatible. Moreover, it should not be a major barrier to trade. After all, it only applies to a small and rather disparate selection of carbon-intensive products prone to carbon leakage: cement, iron and steel, aluminum, fertilizers, electricity and hydrogen. And, for the most part, these are not things that are traded over great distances.

Electricity, for example, is sold only over short distances; It is included in the MAFC to guarantee the inclusion of the highly carbon-intensive electrical energy produced in the Balkans. Cement and fertilizers are also imported mainly from nearby neighbors such as Turkey and North Africa. Hydrogen is selling for less, at least for now.

In short, the MAFC covers only approximately 3% of all imported goods entering the EU, with a total value of 50 to 60 billion euros per year. While the EU’s trading partners will complain, especially about the inclusion of steel products, for most countries the MAFC will be a minor irritant at worst.

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For some climate change researchers, that is precisely the problem: MAFC does not cover a large range of products, nor a large percentage of emissions. However, although MAFC constitutes a small percentage of total imports, these products represent almost half (47%) of the free emission rights currently granted to the European industry.

Therefore, MAFC will be beneficial to the public exchequer. Imports covered by the MAFC are estimated to involve direct emissions representing around 80 million tonnes of CO2. At an ETS price of €90 per ton, this would mean annual revenues of around €7.2 billion, which would go directly to the EU budget and provide much-needed slack for other expenditures, such as support for Ukraine.

The revenue collected by the MAFC will be equal to 15% of the value of covered imports, making the mechanism similar in size to the various tariffs on steel and aluminum products imposed by former US President Donald Trump under on the pretext of protecting national security. For critics of the MAFC, it is worth noting that the aforementioned tariffs, which have since been replaced by other forms of trade management, have only had limited success in protecting the US steel industry.

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The EU’s carbon border tax, although imperfect, is economically equitable and unlikely to cause significant damage to the global trading system. On the contrary, it will encourage other countries, perhaps even China, to introduce carbon pricing mechanisms, so that the national governments of those countries, instead of the EU, can collect the revenue. However, this does not mean that MAFC does not pose a risk. In particular, it may raise tensions between friends, especially between the EU and the United States, although perhaps not in the way one would expect.

The United States chose not to impose a carbon tax on industry and instead chose to offer carbon capture and storage (CCS) incentives under the Inflation Reduction Act. The benefits US companies receive from carbon capture and storage ($85 per ton of CO2 permanently stored) are not far off the current ETS price. This means that US steel producers can use the carbon capture and storage subsidy to produce low carbon steel at a cheaper price than their EU competitors, who will face the same incentive to decarbonise. , but they will bear the cost themselves. . This would attract investment to the United States and leave the EU steel industry complaining about unfair competition.

Therefore, it is not the EU’s MAFC, but US policy that threatens to fuel trade tensions between the allies. This is just one of the unintended consequences of the United States’ late adoption of a climate policy that does not include a carbon tax.